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A Penney Saved?

March 28, 1999

Marketing: Retailing

A Penney Saved?

CEO Oesterreicher has a plan, but investors are balking

James E. Oesterreicher, chief executive of J.C. Penney Co., knows a thing or two about pressure. In the early 1990s, he was head of Penney's department stores and catalog division when the retail giant hit the skids. Penney had launched an ill-conceived push into higher-priced goods just in time for the 1990-91 recession. But under Oesterreicher's guidance, the chain quickly recovered by creating promising private-label brands and rebuilding its reputation as a place to buy conservative clothing at reasonable prices. If Penney wasn't cutting-edge, at least it was reliable. That strategy led to a record $1.1 billion in profits for the retailer in 1994.

Penney has gone downhill ever since, and the pressure on Oesterreicher has never been more intense. In late February the Plano (Tex.)-based retailer reported yet another year of disappointing results. Net income last year edged up to $594 million, nearly half what it was in 1994. Sales last year rose 0.4%, to $30.7 billion, mostly from its 1997 acquisition of drugstore chain Eckerd Corp. Meanwhile, Penney's stock has plunged 50% in the past 12 months, to 39.

Now, some investors are openly calling for Oesterreicher's ouster. And there are signs the board may be listening. "The pressure is on Penney's management team to turn this company around--and to do it quickly," says Donald E. Brown, an analyst for Public Employees Retirement System of Ohio, which halved its Penney stake over the past year, to 300,000 shares.

When Oesterreicher, 57, took over the top job in 1995, investors had plenty of reason for optimism. Penney seemed poised to cash in on a trend in middle-market retailing in which department stores turned high-margin private labels into core brands. Oesterreicher had already helped launch a group of money-making house labels, most notably The Original Arizona Jean Co., a line that gave rivals Levi's and Lee a legitimate competitive fright. Artsy TV ads, fashionable styling, and low prices, made the line a hit.WIDELY COPIED. But Penney, whose largest supplier was and still is Levi Strauss, didn't go in for the kill. Arizona never rose to a megabrand. Nor did Worthington, a line of women's clothing, or any of Penney's other in-house labels. And while the retailer failed to fully promote and capitalize on its own brands, the private-label apparel tactic was widely copied to great advantage by rivals. Sears, Roebuck & Co., which long had market-leading house brands like Craftsman and Kenmore, built its own clothing labels.

Meanwhile, middle-market and lower-end department stores began eating Penney's lunch. Macy's, for example, lured the traditional Penney customer by cutting prices and offering a wider variety of national brands such as Tommy Hilfiger and Ralph Lauren. Sales at Penney stores open more than a year fell by 1.9% last year, while rivals such as May Department Stores and Federated Department Stores saw same-store sales rise by 3.5% and 2.2%, respectively. Meanwhile, discounters such as Target Stores and Kohls Corp. gained ground by offering clothing quality comparable to Penney's, but at much lower prices. While all this was happening, Penney made few significant changes in store design, merchandise, or marketing. "Penney has failed to reinvent itself," says New York-based retail consultant Howard Davidowitz. "You have to call it a terrible management failure. In retailing...you have to keep changing and moving forward."

Oesterreicher brushes off such criticism. "I think it's important for people to visualize where we're going and not where we've been," he says, while conceding that he needs to "get our department-store and catalog businesses back on track."

In Oesterreicher's latest turnaround effort, Penney will reemphasize the quality and affordability of its eight key apparel lines, including Arizona, Hunt Club, and Worthington. Oesterreicher plans to showcase them in 5,000-to-6,000-square-foot "Power Shops" located within Penney stores, setting them apart as an upscale store might show off designer labels. The initiative includes efforts to speed merchandise into the stores, come up with a new store design, and boost Internet presence.STALE STORES. The moves have done little to still the critics. "That's not much to get excited about," says analyst Richard L. Church of Salomon Smith Barney. The problem, outsiders say, is that the new plan just isn't new enough. "Geez, Federated and May have been doing [private-label shops] for years," says Peter M. Lovell, a portfolio manager at Invesco Funds Group Inc., one of Penney's largest shareholders. Lovell and others say the private-label shops don't go far enough in updating Penney's tired look. "Penney's stores have been stale and flat, and they need to do something to get people's attention," Lovell says.

Oesterreicher says his current plan will be more successful than past efforts because it relies on extensive customer market research. "This one is more specific and less general, and there's commitment throughout the organization. Once you decide where the target is, where the guidelines are, you can focus your energies on achieving something," says Oesterreicher.

But time may be running out for him to get it right. Some shareholders, retail experts, and former Penney executives are calling for radical realignments at the company--starting with the chief executive's office. "It's time for a change, and change begins at the top. [Oesterreicher] has to be held accountable," says Thomas M. Buynak, director at Cleveland-based Society Asset Management, which has dumped 1.2 million Penney shares since last fall. "I think the board has a fiduciary duty to ask itself if they have the right guy running this company."

While several directors declined to comment, certainly some changes appear to be afoot at the retailer. In January, John T. Cody Jr., 60, a 35-year Penney veteran and its president and chief operating officer since 1997, abruptly announced his retirement. In a break with tradition, Penney says it is looking outside as well as within its ranks to replace Cody--and to fill future senior-level openings.

Penney executives say Cody's departure is unrelated to the company's recent performance, noting that top officers typically retire around age 60. But observers say there's more to the recent announcement than that. "The board was looking for change, and it had to start somewhere," says one former top Penney executive. He adds: "Some would say it's Oesterreicher it should be targeting." If things don't get better soon, that may be exactly what happens.By Stephanie Anderson Forest in DallasReturn to top